Dealing with a wide range of high-interest debt from different sources that you are having trouble paying off.
Making debt payments in an organized way will allow you to have an easier time with it. In this context, the debt avalanche technique is a great option to pay off debt. In this article, you will learn more about what this debt repayment method means, who it works for, and more.
What is Debt Avalanche?
As the name suggests, "debt avalanche" involves paying down debt in descending sequence per their interest rates. To be specific, debtors with multiple existing debts first pay off the one with the highest interest rate, then the debt with a lower interest rate, and so on.
How to Use The Debt Avalanche Strategy?
The debt avalanche method works in a stacking sequence, i.e., arranging the debts one by one. Here, one has to stack them by interest rates, starting with the highest interest debt and so on. Generally, there are specific steps debtors take when using this strategy. Here’s the breakdown for you.
Step 1:
First, you should review all your existing debts and categorize them in a list from highest to lowest balance. Then, list their respective minimum payment amount:
| Loan | Balance ($) | Interest rate (%) | Expected minimum payment ($) |
|---|---|---|---|
| Credit card no. 1 | 5,000 | 18 | 200 |
| Credit card no. 2 | 2,000 | 15 | 80 |
| Credit card no. 3 | 3,000 | 10 | 120 |
| Credit card no. 4 | 4,500 | 12 | 180 |
Step 2:
Next, you should assess the list carefully. You have to make a minimum payment of $580 per month to pay off your bills towards all four credit cards.
Step 3:
After this, you should check your income and your monthly budget, including other expenses you need to make. After paying off all bills, check how much you are saving in your emergency fund. For example, if you save $400 of your income in your safety net, keep aside $200 from this for debt payoff.
Step 4:
You can take some of that money to pay off more of what you owe to the card with the highest interest rate. As per this sheet, credit card no. 1 has the biggest principal balance with the highest rate, so prioritize paying off this bill first. Besides the compulsory minimum payments, you should use the extra $200 towards credit card no.1.
Step 5:
Continue until you have fully paid off the total balance. Then, use the extra amount to pay off the credit card with the next highest interest rate, i.e., credit card no. 4. Repeat the process for the other cards next.
Debt avalanche- pros and cons
Of course, all strategies have their good and bad sides. For this strategy, you can expect the following pros and cons.
| Pros | Cons |
|---|---|
| This is a very organized way to approach debt relief. So, this strategy is best for people who perform better with a structured format. | You need to have extra savings to rearrange your budget for this purchase. So, the method is unsuitable for people with a limited budget. |
| When you pay off the highest-rate debts, you will get back the equivalent amount. So, you will save money. | Many people lose the motivation to continue this long-term, so you risk falling into revolving debt again. |
| This is a fast way to get out of debt when compared to other methods, like debt snowball. | Consistently paying all outstanding balances will take time. |
When should you use the debt avalanche strategy?
Debtors find this debt repayment plan most valuable when they have high interest debt from many sources, like credit card debt from many credit cards. However, this strategy works against different debt types, too.
The following are the main types:
- Credit cards- Credit card companies typically charge high interest rates to applicants because credit cards have revolving debt risk. If you use your credit card responsibly, like paying off the credit used by the next paycheck, you can stay out of debt. Yet, some credit card users pay only the monthly minimum payment instead of paying the entire principal balance by the due date. So, they fall into revolving debt if they only pay minimum payments while still using the card for other purchases. Using the debt avalanche method, one can first pay off credit card bills from highest to lowest balance.
- Personal loans- When you borrow money from private lenders, banks, or credit unions, they can charge different interest rates. So, you can use the debt avalanche method if you are paying off many loans. Pay the minimum payment for each loan and add extra from your budget towards the loan with the highest rate.
- Student loans- Private student loans can come with different interest rates. They can range between 1% to 13%. On the other hand, federal student loans are also available with fixed interest rates, ranging between 4.99% to 7.54%.
- Medical bills- It is possible to use this strategy to clear medical bills at the discretion of the hospital. Some of them might charge an additional interest with the debt payoff plan.
- Car loans- The average interest rates of most car loans are between 4% to 8%. However, people with a bad credit score can get risky deals, like a loan with 18% interest. Reportedly, the average interest rate of auto loans was 7.03% and 11.35% for new and used cars, respectively, in the third quarter of 2023. So, you can use debt avalanche to pay off auto loans.
You can use the debt avalanche method if you have debt from one type (e.g., credit card debt) or a mix of many loans. But if you have a mortgage loan, this strategy is not suitable. That is because mortgage rates are typically lower in general.
Alternatives to Trust- What Other Ways Will Work to Relieve High-Interest Debt?
While debt avalanche is a top-notch option for removing debt with the highest interests, it might not work for everyone. If you want to try another strategy for tackling your debt with the highest interest rates, the following are the best options.
Debt consolidation loan
You can take a debt consolidation loan to pay off your high-interest debt in place of the debt avalanche strategy.
The process involves combining all your debts into one. Then, with the support of a reliable debt relief company, you will get a personal loan with a unified interest rate- use that to pay off your debt to your creditors. Next, you have to make monthly payments to this loan within a new repayment timeline.
While this method is excellent for slowly repaying all your debt, you should prioritize paying it off on time so it doesn't badly impact your credit score.
Balance transfer credit card
If you have a lot of high-interest debts, like many credit cards to your name, getting a balance transfer credit card should help you. Here, you will consolidate all balances from your multiple credit card bills into one sum. Then, apply for a new balance transfer credit card and move this total amount into that card as the principal balance. Next, you must make minimum monthly payments towards this new card until you clear the whole debt.
With a balance transfer credit card, you can expect an introductory 0% APR, e.g., no interest charged for the first year. However, you will get a very high interest rate after this period passes. So, try to pay off the bulk of it within the introductory year.
Debt snowball method
The snowball method is a good alternative you can look into if you find debt avalanche unsuitable for your situation. Unlike the latter, you will start with the small debts first here. One by one, you can pay off your debt fully.
To give an example, let's say you have a personal loan debt of $4,000, a student loan debt of $2,000, and a credit card debt of $5,000. In this process, you should pay off the minimum monthly payment for all unsecured debt types. Then, use a big chunk of your leftover amount towards paying the smallest debt until you pay it off completely. Next, you can move to the next smaller debt while paying off the necessary minimum payments.
"It's a strategy that resonates with many, offering a blend of practicality and psychological satisfaction," says Ankit Prakash, founder of Sprout24. "Quick wins provide a sense of accomplishment, encouraging individuals to maintain their debt-reduction efforts." Thus, you will likely make your payments steadily and pay off your debt over time with the debt snowball plan.
Debt snowflake method
The debt snowflake option also works well as a debt reduction alternative. In this method, you can use any extra money you earn towards paying off the smallest debt. While it works entirely opposite to the debt avalanche strategy, the plan works well for clearing off high-interest debt in small spurts. If your budget is tight, this method is suitable for you.
However, you must consistently follow this method for a long time to pay off debt satisfactorily. Not to mention, you cannot predict when you will get such windfalls, like a small bonus. So, use this debt repayment strategy alongside another debt relief method, like debt avalanche, instead of relying on it entirely.
Peer-to-peer lending
You can also try peer-to-peer lending to clear out all your debts with the highest interest rates.
Here, debtors typically borrow money from individual investors instead of conventional financial institutions to get lower interest rates.
To explain, debtors can apply for peer-to-peer loans from individual investors instead of banks or credit unions. Using the loan amount, they can pay off their multiple debts with higher interest rates, i.e., their total outstanding debt from many credit cards. Then, they get one new manageable monthly payment structure to repay this loan. "It's important to research reputable peer-to-peer lending platforms," suggests Roy Lau, co-founder of 28 Mortgage. "Weigh the terms and interest rates before proceeding."
Final Verdict: Should you try the debt avalanche method?
All things considered, the debt avalanche method is very suitable for clearing high interest debt quickly.
However, you have to put in long-term effort and discipline to pay off all high-interest bills properly. Plus, you need to have sufficient income that you can rearrange to make the extra payments. Thus, you should try this method only if you are sure you can be consistent with it. Alternatively, a debt consolidation method like a debt consolidation loan or a balance transfer credit card will suit you, especially if your credit score is high.
Other strategies also work. Take time to understand your financial goals and situation to choose the right one.
